Aramark's Million Meals Provides Diverse Revenue Stream

Back on the stock exchange since December, the global food services provider edges into government contracts, like serving cheap meals to inmates

A million meals a day is a pretty good business model and that is exactly what Aramark Correctional Services, a division of Aramark(NYSE:ARMK) accomplishes.

"ACS prepares well over 1,000,000 meals a day for state and municipal facilities, partnering with our clients to meet the unique challenges of the corrections environment," the company website states.

Prison economies

Most people know Aramark the global food services company. Likely not as well-known but nonetheless illustrative of the power of prison economies is its corrections services division. Aramark actually provides more than just groceries to prisons and jails. Aramark provides prepared meals to more than 600 jails and release centers.

This service grew during the Great Recession crunch on state governments when desperate states began looking for ways to cut budgets. It is saying something that Aramark could provide cheaper meals, cooking them and delivering them, than jails themselves could make using free inmate labor.

Aramark reentered the public stock market with a December offering, as Fool contributor Gerelyn Terzo explained. The SEC filing mentioned new business to the likes of professional football teams (i.e., Minnesota Vikings, Chicago Bears and Tampa Buccaneers) and the Ohio and Michigan departments of corrections. These were some of the million meals a day the company prepares and delivers.

Stop and consider this business model for a moment. The scope of this food service is astounding. ACS routinely prepares meals sufficiently luxurious and nutritious to satisfy a professional athlete, or simple enough for fans watching them compete, and meals so cheap that it beats the budgets of county jails using free labor. If such a thing as a gamut exists here, ACS runs it daily.

Cautious, yes, but...

Investors have plenty of reason to be cautious about Aramark, starting with a basic concern over whether the third time is really a charm. As Terzo pointed out, "Aramark has a pattern of entering and exiting the public markets, having IPO'd twice before--first back in 1960 and then again in 2001. Meanwhile, the size of its debt load has exploded in the process."

Still the company has its fingers in a lot of pies specializing in a type of service that few others could hope to compete. How does a rival company suddenly try to cut into prison food prep to such a degree to turn a profit and compete with the 600 facilities already served by Aramark? In its Jan. 14 SEC filing, corrections makes up 4% of the companies total revenue. All together, its food services in North America makes up 69 %of the companies revenue.

For all it does offer, even Sysco(NYSE:SYY) can't compete with Aramark in this arena.

Prepared foods allows Aramark into places of competition with the likes of Sysco. For example, Sysco now claims 36% of the health care market. But if Aramark can convince hospitals, retirement homes and the like to outsource kitchen staffs, they could soon eat into Sysco's strongest marketshare.

Most importantly, governments are increasingly looking to outsource prison-related expenses. The run-up that tripled the number of incarcerated people over the past twenty years was highly profitable for many reasons, not the least prison construction. But operations is another costly matter and the true costs of "tough-on-crime" legislation is now coming due. Governments routinely turn to privatization when this occurs. Here Aramark is well-positioned to grow its market share rather than retract.

Aramark's profit margins comes from volume. With the small profit margins needed to compete, as best exemplified by its competition with free prison labor, the company aggressively markets to new outlets in education, health care and corrections. Without increasing volume, the company's revenue will stall.

"We believe that our broad range of services, diversified client base, global reach and repeatable business model position us well for continued growth and margin expansion opportunities," Aramark's Jan. 14 filing stated.

In 2013, the company generated $13.9 billion in sales and $70 million in profit.

The potential for growth remains high as all of these institutions work on narrow margins with pressure to reduce costs.

The down sideLike other notable prison-based economies, Aramark is not above the maelstrom of public complaint and potential litigation, but it should not by itself scare off investors. Prison reform groups and bloggers frequently take shots at the quality of Aramark food being served to those inmates, but investors would do wise to take it with a grain of salt.

Typically the company is only required to provide a set amount of calories each day. So huge helpings of margarine are added to the calorie count, or subsidized corn products like corn cakes routinely take the place of more expensive flour pancakes. These "efficiencies" are not well received by those eating them. As could be expected, lawsuits have already been filed.

I suspect none of this was unexpected or news to ACS brain-trust, who like many large companies factor in the legal costs and public backlash when taking on new potentially controversial accounts. But as we noted above, the corrections slice is not the whole pie. Government contracts for schools, corporate contracts like Airbus and a host of others comprise those 1 million meals.

The biggest risk factor for Aramark is not bad press, but bad debt. It carries $5.8 billion in debt, which remains a concern to its long-term outlook. The company plans to pay down $372 million in outstanding loans due in 2016 through proceeds from its latest IPO. How it further reduces that debt in the years to come will say a lot about its future.